COLLEGE PLANNING | ESTATE PLANNING | INSURANCE | INVESTING | PORTFOLIO SPOTLIGHT | REAL ESTATE | RETIREMENT | TAX PLANNING
Public Or Private Debt ?
Which one is better for your fixed-income allocation ?
By Larry Swedroe
PUBLICLY TRADED BANK LOANS AND high-yield bonds have offered some investors diversification in their traditional 60 / 40 portfolios . However , for investors willing and able to accept at least some degree of illiquidity , private credit offers returns that have been 3 % to 4 % higher ( when adjusted for fees ). That should be more than sufficient to compensate investors who don ’ t need liquidity for their entire portfolio ( which is almost all investors ).
Over the past three decades , regulatory reform and industry consolidation have driven banks to curtail corporate lending activity . To fill the gap , “ private direct lending ” has emerged , with independent asset managers funded by capital from institutional investors , replacing banks as providers of secured first-lien commercial loans . By 2024 , the private credit market had grown to more than $ 2 trillion globally , with about three-quarters of that in the United States , where its market share is nearing that of syndicated loans and high-yield bonds . ( See the chart on the following page .) Note that while the private market has grown rapidly , it still represents a small fraction of the total corporate debt market of about $ 14 trillion .
As the chart shows , the market has grown rapidly , and the speed , flexibility and certainty of execution that direct lenders provide have proved valuable to borrowers and their private equity sponsors . Though private credit is illiquid , institutional investors such as pension funds and insurance companies are attracted by the higher returns and reduced volatility . Individual investors should be too .
Public Versus Private Credit Performance
The table on the next page shows a performance comparison between the Cliffwater Direct Lending Index , as well as the version of the index that ’ s net of fees , next to the public credit benchmarks . The net-of-fees index was created to provide onehalf of an apples-to-apples private-public credit comparison . It ’ s different from the regular Cliffwater direct index in that the management and administrative fees are deducted from returns ( according to quarterly business development company disclosures ). The resulting quarterly return series in the net-of-fees version parallels the after-fee , unlevered returns reported by public bank loan funds , exchange-traded funds , and separate accounts , though not the index of Morningstar LSTA , where returns are formulaic and without fees and transaction costs . (“ LSTA ” stands for the Loan Syndications and Trading Association .)
As you can see , investors are picking up almost 4 % in added net-of-fee return from private credit ( 7.23 % minus 3.31 %) despite paying an additional 1 % or more in higher expenses . The cost of unlevered private credit ( the difference between the Cliffwater index and its net-of-fees index return ) has been about 2 % per year while the cost of public credit ( measured by the difference between the Morningstar LSTA U . S . Leveraged Loan 100 Index return and the return of a fund that tracks it — the Invesco Senior Loan ETF ( whose ticker is “ BKLN ”)— has been about 1 % per year . Note also that the volatility of private credit has been lower .
36 | FINANCIAL ADVISOR MAGAZINE | NOVEMBER 2024 WWW . FA-MAG . COM